Forget 47%. Only 1 in 7 Would Face Levy With First System

Feb. 1 (Bloomberg) -- If the U.S. had the same income tax
rules it did when the levy started 100 years ago this weekend,
86 percent of households would be exempt from paying it.

That figure, according to data compiled by Bloomberg, far
outpaces the 47 percent estimate for nonpayers cited in last
year’s presidential campaign. The first levy, adjusted for
inflation, would only affect individuals with taxable incomes of
more than $69,574 a year -- and then with a bottom rate of just
1 percent and a top marginal rate of 7 percent.

The original income tax, if still in place, would raise
about $45 billion, or 3 percent of what today’s individual
income tax generates, said Bloomberg Government analyst Patrick
Driessen, who generated the estimate by applying the 1913
brackets to today’s income patterns.

“These were really taxes on the rich,” said Carolyn
Jones, a law professor at the University of Iowa who studies the
history of U.S. taxation.

Today’s debate in Washington over the size of government
and how to pay for it can be traced to the enactment of the
Sixteenth Amendment, which permitted the tax. Its creation set
the U.S. on the path toward a larger central authority and
cemented distributional politics, in which the government could
fine-tune economic policy to steer tax breaks to favored groups
and extract money from others.

Amendment’s Text

The amendment, ratified on Feb. 3, 1913, in the waning days
of Republican William Howard Taft’s administration, changed the
Constitution for the first time in 43 years. The one-sentence
statement gave Congress the “power to lay and collect taxes on
incomes, from whatever source derived.”

The amendment was written in response to an 1895 Supreme
Court decision that invalidated a prior income tax. The drive to
re-create a levy first imposed during the Civil War was
propelled by a coalition of economists and populists, Jones
said.

“It was significant in terms of moving away from a tariff-based consumption tax and reliance on sin taxes to something
that more resembles ability to pay,” she said.

President Woodrow Wilson, a Democrat, signed the modern
income tax into law Oct. 3, 1913, combined with a reduction in
tariffs. The first 1040 form emerged soon after from what was
then known as the Bureau of Internal Revenue, and it applied
retroactively to income earned starting on March 1.

Tax Form

That initial tax form is a model of simplicity, weighing in
at four pages, including instructions.

It didn’t incorporate many features of today’s tax system.
Taxpayers didn’t have preferential rates on capital gains and
dividends. They couldn’t deduct charitable contributions. Still,
they could deduct all interest “on personal indebtedness of
taxpayer.”

The 1913 tax code set a basic 1 percent tax rate on annual
income exceeding $3,000 for individuals and $4,000 for married
couples. A “super tax” with six 1 percent steps began at
$20,000, or about $464,000 in today’s dollars.

The threshold for the top rate -- the 1 percent tax and a 6
percent super tax -- began at $500,000. In nominal dollars,
that’s actually higher than the $450,000 starting point for
today’s 39.6 percent top bracket for married couples.

In inflation-adjusted dollars, the 1913 tax code would
spare everyone from the highest tax rate except those earning
more than $11.6 million.

The estimates of the income break points come from using
the Bureau of Labor Statistics’ inflation calculator.

World War I

The income tax expanded when the U.S. entered World War I
in 1917. Jones said the additional revenue source provided by
the levy allowed the government to ban the sale of alcohol and
forgo the accompanying tax revenue in 1919.

A mass tax wasn’t needed until World War II, when it was
used to fund the war and restrict domestic inflation, Jones
said. After the war, President Harry Truman’s administration
chose to keep the broad-based tax to ensure financing for a
defense buildup for the Cold War.

Attention to the current 47 percent who don’t pay income
taxes emerged during the presidential campaign last year with
the release of a recording of Republican candidate Mitt Romney
talking to donors. Republicans’ low-tax message, he said,
doesn’t resonate with nonpayers, who expect benefits from the
government.

“And so my job is not to worry about those people,” he
said. “I’ll never convince them that they should take personal
responsibility and care for their lives.”

Romney Comments

Democrats seized on Romney’s comments -- and pushed tax
credits for families and education through Congress on Jan. 1
that will keep more households off the income tax rolls.

The Sixteenth Amendment itself makes occasional entries
into contemporary politics. The Republican Party’s 2012
platform said that any value-added tax or national sales tax
“must be tied to the simultaneous repeal” of the amendment.

The income tax has caused U.S. economic growth to be slower
than it would be otherwise, said Will McBride, chief economist
at the Tax Foundation, a Washington-based group that favors a
simpler, flatter tax code.

“As a direct result of the burden of the income tax, and
the fact that so many people pay it, over the years there’s been
an accumulation of ways to take it apart, to carve out
loopholes,” he said. “It would be completely unrecognizable
and unpredictable. It didn’t evolve in any sort of rational
way.”